Are United And Alaska Setting The Stage For A Fare War? That's Analysts' Fear And Travelers' Hope

Dan Reed
, ContributorI write about airlines, the travel biz, and related industriesOpinions expressed by Forbes Contributors are their own.

A Fare War? Millennials may be unfamiliar with the term, which was commonly used to refer to intense pricing battles among airlines to steal passengers from each other in the 1980s and 1990s.

But -- and it’s a huge “but” at this early stage -- there’s real potential that they could experience a fare war, albeit a small one, for the first time in their short adult lives.

United Airlines executives on Wednesday went public with their new capacity growth forecast for 2017. Instead of adding only between 1.5% and 2.5% to their capacity – measured in available seat miles – as it previously had said was the plan, the nation’s third-largest carrier now expects its capacity this year to end up being between 3.5% and 4.5% greater than it was last year.

That may not sound like much to those who don’t watch airline competition as intently as the way many of us will be watching the NCAA basketball tournament this weekend. But it’s more than enough to make analysts’ and investors’ knees’ go a bit wobbly. In an industry where the difficult task of getting an extra two or three seats filled on a flight can mean the difference between that flight being a painful loss-maker or handsome profit earner, a full 2-percentage-point increase in planned annual capacity growth can be sobering. Such an increase equals the addition of tens of thousands of additional seats to a network the size of United’s. And consumers will not just magically appear to fill them without the airline doing something to attract them.

Scott Kirby, seen here in a 2013 photo, earned a reputation as an aggressive competitor as the No. 2 executive at America West, US Airways and American Airlines (all of which are now part of American via multiple mergers he helped engineer). Now he's turning up the volume at at United Airlines, where he named President last August by United Chairman Oscar Munoz. Photographer: Laura Segall/Bloomberg

United appears to be counting on strong economic growth in the U.S. economy, where most of that new capacity will be added, to fill all those new seats. But if, as is likely, that fails to generate enough additional traffic on its own United will have to use its most powerful marketing tool – price cuts- to do the job. And once it does that you can expect competitors American, Delta and others to match or beat United’s discounted prices.

It wouldn’t take much of that kind of competitive back-and-forth to blossom into a fare war like those we’ve really not seen much since the late 1990s. And that, clearly, is a concern among analysts.

They spent the first six to nine months of 2016 publicly wringing their hands and nagging airlines’ leaders about overcapacity that was visible in a key industry metric: Passenger Revenue Per Available Seat Mile, or PRASM. That stat provides a clear indication of how much demand exists for air travel at various prices.

A high or rising PRASM indicates that demand is strong or strengthening and the airlines probably can get away with bumping their fare prices a little higher. Conversely, a weak or declining PRASM indicates that demand is weak and that airlines are having to cut prices to fill seats.

Beginning late last summer and into the fall, most U.S. airlines, including United, began responding to analysts' loud calls to more tightly limit capacity growth. Analysts and investors cheered, sending airline share prices soaring.

Everyone seemed so happy.

So what changed?

The seminal event came late last August when United CEO Oscar Munoz hired an aggressive and intense new president for his airline. Scott Kirby, who had held the same title at American, now has his fingerprints are all over United’s strategic shift, which is aimed at improving United's laggard status in terms of its financial performance metrics. It’s moving some of its existing capacity out of the transatlantic market, where the strong dollar and Europe’s political turmoil is suppressing demand, and into the domestic market, where United had been in retreat for a number of years. And its adding new capacity in the domestic market, with both new planes and small jets operated by its regional airline affiliates flying under the United Express banner.

Most specifically, Kirby is leading United to beef up domestic flights into and out of its key hubs in Chicago, Denver and Newark. Why? Because moving passengers from smaller towns through big hubs is how airlines make the most money, at least in the domestic market. Passengers traveling to, from or between smaller cities via connections at a big hub tend to pay more on a per-mile basis than those who begin or end their trips at a hub.

Kirby also recently explained that 87% of United’s revenue comes from travelers who fly aboard its planes just once a year or even less frequently. That means those passenger lack any strong ties to, or preference for United. So, he says, United needs to be more aggressive in trying to attract them to its flights and moving them through its hubs - and away from the flights and hubs of its rivals.

The expected result will be increased competition, especially on routes tied to Chicago, the only U.S. city where two carriers – United and American - operate hubs in head-to-head competition.

Meanwhile, United’s not alone on the accelerated growth plan. Seattle-based Alaska Airlines, which recently acquired Virgin America and is in the early planning stages for combining the two operations, announced Wednesday that it will be significantly beefing up service at San Diego and in a number of other western cities. Alaska executives are keenly aware that as their carrier gets bigger via acquisition it is becoming a bigger competitive threat to its larger competitors. So they are moving quickly to strengthen their position out west by adding capacity even before the operational merger with Virgin American can take place.

Certainly we can expect American to react forcefully to United’s play. Nor will Delta, which competes with United just as much at American does on a nationwide and global basis, sit on its hands. Southwest, too, competes with United both for leisure passengers and price-sensitive business travelers at its big operation at Chicago’s Midway Airport and also nationwide in big markets like Houston, San Francisco, and Denver. And all of them can be expected to counter Alaska’s moves out west, where no one carrier is dominant.

The only question, it seems, is the degree to which the newly-intensified airline competition will heat up? There’s no clear line marking the point where such increased fare-price competition becomes an honest-to-goodness fare war. But the increased competition will benefit consumers in any case.

Alas, investors, likely won’t benefit from it - not unless they happen to be shorting airline shares.

About the only thing airline investors can hope for is lower fuel prices. And they might get lucky on that. After hovering in the $51 to $56 dollar-a-barrel range up since early December, West Texas Intermediate crude has tumbled nearly 10% in the last week amid signs of increased global oil production. Saudi Arabia's recent decision to ease back by a third on production restrictions it had imposed on itself last year triggered the price drop in the market, where WTI closed Wednesday at $48.86.